Russia’s Arctic Opening

When it comes to Russian oil and gas, major deals with foreign companies are a good deal like London buses: Just when you’re about to give up waiting for one to come along, three or four turn up at once.

Already, 2011 has been a bumper year.

In January, BP sought to ensure its future as a major international player by announcing a landmark $16 billion alliance — now on the rocks — with Russia’s state-run Rosneft. The company’s chairman, Igor Sechin, is also Russia’s deputy prime minister. Facing a multi-billion dollar tab from last year’s Gulf of Mexico spill — and the prospect of being frozen out of operating roles in the United States for years — BP agreed to swap a chunk of its own equity for a share of Rosneft and cooperate in a new Arctic venture in the Kara Sea, with the blessing of the Kremlin but, perhaps fatally, without the benediction of BP’s Russian business partners in TNK-BP.

Later the same month, on the margins of the World Economic Forum annual meeting in Davos, Switzerland, executives at ExxonMobil struck a deal with Rosneft to develop offshore fields in the Black Sea.

In early March, France’s Total bought a $4 billion stake in Russia’s leading independent gas company, Novatek. Less noticed — but of considerable long-term significance — the same week saw Russia’s state-run gas giant, Gazprom, secure ownership of Kovykta, a Siberian gas field that will ultimately be used to pump gas to the hungriest energy consumer on the block: China.

Together, these deals reflect Moscow’s growing appetite for partnerships with international companies in areas that require hefty investments of technology and money, coupled with a strategic desire to assert control over relatively easy-to-produce assets.

In one sense, this is nothing new. International companies have a long and tortured history of involvement in Russia’s hydrocarbon development, stretching back to the Rothschilds and the Nobels more than 100 years ago.

Much of this history has depended on the ebb and flow of power between resource-rich Russia and companies with the means to develop those resources. In the 1990s, with oil prices low and a weak Russian government, companies’ bargaining position was strong. After 2000, with rising prices and a more assertive Kremlin, power shifted back to the state.

Now, Russia seems attractive — and receptive — once again. With large parts of the world off-limits to outsiders and the Middle East in turmoil, international oil companies increasingly see Russian assets as an indispensable part of their portfolio. Russia, meanwhile, needs international expertise, and money, to keep production high.

But these latest deals involve two new elements that point to the longer-term future of Russian hydrocarbons.

First, two of the deals have an Arctic focus, moving beyond the more southern fields that have fed Russia’s energy superpower status for years. It is an ironic twist of business logic that one of the indirect consequences of the Gulf oil-spill disaster has been that BP has attempted to enter an agreement to develop hydrocarbons in the environmentally sensitive offshore Russian Arctic. (As Russia’s ever-colorful prime minister Vladimir Putin put it: "One beaten man is worth two unbeaten men.")

The Total-Novatek deal, meanwhile, opens the way for Total’s involvement in the huge onshore Arctic Yamal gas deposit, with a development price tag of $20 billion. (Development of the giant Arctic offshore Shtokman gas field, in which Gazprom is partnering with Total and Norway’s Statoil, is slated to come into production in 2016 — but many expect that timeline to slip).

Second, Russia is attempting to recalibrate its hydrocarbon focus from Western countries to those in Asia. American shale gas has exploded the commercial logic of large-scale liquefied natural gas (LNG) exports to the United States: America may be able to get all the gas it needs out of its own ground. U.S. oil imports have already been declining for several years.

The European energy market is huge, but mature. The prospects for growth in European gas consumption are limited. China, meanwhile, is hungry. It is already more dependent on imported oil and gas than the United States, and its needs are projected to increase dramatically in the coming years.

Some Russians fear that, over time, the sparsely populated Russian Far East will become a Chinese economic dependency: There are (almost) as many people in the single Chinese border province of Heilongjiang as in the whole of Russia east of the Urals. Other Russians express a different concern: that they are not getting enough Chinese investment to truly scale up hydrocarbon exports, whether from the Arctic or not. Rosneft has been talking to the China National Petroleum Corporation about offshore Arctic exploration for years.

The environmental dangers of Arctic development are monumental. So is the prize. A BP press statement announcing the potentially spiked Rosneft deal described it as opening up "an area roughly equivalent in size and prospectivity to the UK North Sea."

For Russia, the Arctic is key to boosting hydrocarbon exports on which the country’s economy — and political system — largely depend. For all the pieties about economic diversification repeated by President Dmitry Medvedev and his reform-minded advisers, Russia remains a petro-state. But Arctic development is about more than just maintaining Russia’s oil and gas exports. In the long term, increased hydrocarbon activities would boost shipping along Russia’s Northern Sea Route. This, in turn, could help open up Russia’s vast Arctic interior.

What should observers make of this? First, and fundamentally, whether or not BP is ultimately successful in the Rosneft deal, Arctic development is here to stay — and not just in Russia.

A British company, Cairn, will continue exploration off Greenland this summer. Although developments off the coast of Alaska are controversial — and Shell’s program has been pushed back another year — the United States already produces oil onshore in the Arctic. Norway’s Statoil produces LNG above the Arctic Circle. The Norwegian government has just given a green light to more exploration in the Barents Sea, while a boundary treaty with Russia opens the scope still further. In Canada, a $16 billion proposed gas pipeline along the Mackenzie Valley recently passed a major regulatory hurdle — though U.S. shale gas may yet kill it.

In short, an international treaty to prevent Arctic oil and gas development, on the model of the Antarctic Treaty, is a non-starter. The Arctic states — and the majority of the Arctic’s many peoples — don’t want one.

But if a treaty preventing development is out, there are still international mechanisms for shaping the way development will happen. The Arctic’s premier consultative body, the Arctic Council, may yet be strengthened by its member states (including the United States and Russia) at a meeting in May. Non-Arctic states are increasingly interested.

Second, Arctic development poses huge environmental challenges, and nowhere more sharply than in Russia. Last year, Putin promised at an international conference in Moscow that Russia’s Arctic development would take place with the highest environmental standards. The international environmental NGO WWF has since pointed to the possibility that the boundaries of Russia’s national parks may be redrawn to accommodate development.

There will always be commercial and other pressures to take more risks: to go faster, deeper, further. But baseline science needs to be in place to assess environmental impacts. As it stands, the technology and infrastructure needed to clean up a spill in the Arctic should the worst happen are inadequate.

Third, the involvement of international oil companies, particularly in Russia’s Arctic, should broadly be welcome. It is better for Arctic resources to be developed with Western technology and standards than for it to be attempted without them. There is a strong incentive for cooperation: The industry as a whole will be held responsible if something goes wrong. An environmental disaster in the Arctic would likely have a transnational dimension.

Going forward, it must be a priority to make sure that companies less exposed to the anger of activist shareholders and environmentally sensitive governments adopt the same standards. Russia’s Arctic opening is a huge challenge with tremendous strategic, commercial, and environmental ramifications. It is also an opportunity do things right.